Fast Track General Management Program

Organizing for Global Competitiveness

Prof. Vijay Kumar Indian Institute of Management Bangalore

Feb 15, 2002

PRESENTATION PLAN

I. The Proposition II. Theory of Comparative Advantage III. Flow of Capital - FDI IV. Competitive Advantage V. Determinants of Competitive Advantage VI. A Framework for Creating Competitive Advantage

VII. What Should Companies Do?

I. THE PROPOSITION Global competition has intensified in recent years It is the outcome of movement toward greater international economic integration (Globalization), i.e., freer flow of goods, services and capital. No business, regardless of size , is immune from these forces Nevertheless, companies, industries and countries, large and small, can take steps to not only cope with but benefit from the forces of globalization. Still, there will be winners and losers in this new game. It is crucial to understand the nature of these forces and develop appropriate strategies.

II. THEORY OF COMPARATIVE ADVANTAGE

Flow of goods and services (international trade) is rooted, in large part, on the theory of comparative advantage To paraphrase the theory: - Countries should concentrate on economic
activities where they are better than others - Even if a country is worse than all others in absolute sense it will be better off if it concentrates on where it is less bad (comparative

activities advantage)

Models of comparative Advantage (exhibits)

Thus, Conforming to the theory of comparative advantage leads to: -International division of labor (Specialization)
-Better allocation of resources -Higher productivity -Higher standard of living -World class companies and industries

THEORY OF COMPARATIVE ADVANTAGE (contd.)

But conflict between international economics and national politics leads to clamor for protectionism Further, comparative advantage is a moving object All of this has significant implications for business

THEORY OF COMPARATIVE ADVANTAGE (contd.)

Comparative Advantage Illustration

Two countries: Germany and France Two products beer and cheese Each country can produce each good Resources are finite France more efficient at making cheese and Germany beer.

Comparative advantage illustration (contd.)

Production Possibilities Under Autarky
Germanys Consumption Frances Consumption

100 Beer Production 80 60 40 20 B Beer Production

100 80 60 40 20 A

0
20 40 60 80 100

0
20 40 60 80 100

Cheese Production

Cheese Production

Beer: 2 Barrels Cheese: 1 Pound

Consumption: Beer: 60 Cheese: 20 Actual Beer = 80 Cheese = 80

Beer: 1 Barrel Cheese: 2 Pounds

Beer: 20 Cheese: 60 Maximum Possible Beer = 100 Cheese = 100

Total production :

Comparative advantage illustration (contd.)

Production Possibilities With Trade

Germany would want to sell beer upto 2 Barrels for 1 lb. of cheese France would want to sell 1 lb. of cheese for upto barrel of beer Both countries will gain from trade if price of 1 lb. of cheese is between and 2 barrels of beer. Assume both countries trade 1 lb. of cheese for 1 barrel of beer
Germanys consumption Frances consumption

100 Beer 80 Production 60 40 20

Beer Production

100 80 60 40 20

20 40 60 80 100 Cheese Production Consumption: Beer: 60 Cheese: 40 Additional Consumption: Cheese: 20 Beer: 40 Cheese: 60 Beer: 20

20 40 60 80 100 Cheese Production

Comparative advantage illustration (contd.) Absolute Advantage Illustration Assume Germany and France have same population
Assume France's Productivity increases by 300% It can produce 150 Barrels of beer & 300 lbs of cheese

Germanys consumption

Frances consumption (Note the scales)

100 Beer 80 Production 60 40 20

Germanys Consumption

Beer Production

300 240 180 120 60 20

Frances consumption

20 40 60 80 100 Cheese Production Consumption: Total production: Beer: 60 Cheese: 20 Actual Beer: 80 Cheese : 280

60 120 180 240 300 Cheese Production Beer: 20 Cheese: 260 Maximum Possible Beer:100 Cheese: 300

Comparative advantage illustration (contd.)

Trade-off remains then same Exchange 1 barrel of beer l lb of cheese (Same as before)

Complexity of actual trade does not change the conclusions derived from the theory of comparative advantage

What matters is the relative and not absolute levels of productivity

III. FLOW OF CAPITAL FDI

While trade is goods and services has grown by 6 plus percent over the past 20 years, FDI has increased by 15% annually during this period Investors are motivated by : Prospects of overseas market

Low growth at home

Herd effect Low cost base Access to raw materials FDI often is good for the recipient country : Augmentation of resources Injection of technology, better management practices Higher economic growth Still, it poses competitive challenges to the domestic players.

IV. COMPETITIVE ADVANTAGE Limitations of the Theory of Comparative Advantage The theory is based on factor endowments land, labor and capital: its application is largely to resource-based industries and undifferentiated (commodity) products. It is overshadowed in advanced industries producing differentiated products by globalization of competition and power of technology In advanced industries, the nation of COMPETITIVE ADVANTAGE is more appropriate. The proposition: Countries can and do create competitive Advantage even when they dont have inherent comparative advantage.

Some Truisms No nation can or will be competitive in all or even most industries Competitive Advantage does not stem from: national endowments; manipulation of interest and exchange rates; government support; managed trade; and the like.

V. DETERMINANTS OF COMPETIVE ADVANTAGE

. .

Key determinant of competitivess is PRODUCTIVITY which defines how effectively capital and labor are employed.
A companys future depends an the level of productivity and, more importantly, increase in productivity over time. Productivity is the value of output per unit of labor and capital it depends on the quality of products, features and the efficiently of output Companys achieve high productivity (and competitive advantage) through innovation, which would include (among others):

New product designs; new production processes; new marketing approaches; or a new way of conducting training.
Investments in skill and knowledge; physical assets; brand reputations; and the like

Most innovation is incremental rather than a breakthrough

If requires pressure, necessity, adversity, dogged determination and relentless pursuit of improvements to stay ahead of the competition on a global basis

VI. A FRAMEWORK FOR CREATING COMPETITIVE ADVANTAGE Four inter-related attributes constitute the framework for creating Competitive Advantage : (Exhibit) Factor Conditions: - Position in factors of production such as skilled labor, infrastructure, etc. Demand Conditions : - The nature of home market demand for the industrys products and services; Related and Supporting Activities : Presence / Absence of supplier industries that are internationally competitive; their proximity to buyers

Firm Strategy, Structure and Rivalry : How companies are created, organized and managed as well as the nature of domestic rivalry plus clustering

In aggregate, the four attributes work as a System

Competitive Advantage A Framework

Firm Strategy. Structure,

And Rivalry

Factor
Conditions

Demand Conditions

Related and Supporting

Industries

VII. WHAT SHOULD COMPANIES DO ?

Create pressures for continuous innovation

Seek out most capable competitors as motivators Establish early- warning system and gains first-mover advantage Welcome domestic rivalry in order to grow internationally Globalize selectively to tap other nations advantage without being deterred by your size Use foreign/domestic collaborations (JVS) selectively Exude Can Do attitude and infect the subordinates.

VIII. WHAT SHOULD GOVERNMENTS DO?

Focus on specialized factor creation

Avoid intervening in currency markets

Enforce strict product safety and environmental standards Eliminate / streamline bureaucratic and regulatory processes and procedures

Sharply limit cooperation among industry rivals

Promote goals that lead to sustained investment (e.g. long term capital gains) Deregulate competition

Enforce strong competition policies

Reject managed trade